Can the Service Sector Lift the Market’s Malaise?

Major U.S equity indexes wobbled lower on Tuesday. Bad mojo began brewing early in the morning when the European Commission reduced its 2014 economic growth outlook for the euro region, and strong service-sector data from both China and the U.S. seemed unable to turn sentiment around.

The Institute for Supply Management reported that its headline index for service-sector business activity increased to 55.4 in October from 54.4 in September. This marks 46 consecutive months of growth. ISM’s non-manufacturing Report on Business gauges activity in the notoriously hard-to-measure services sector. The services sector accounts for the majority of gross domestic product and much of the business activity is more relevant to investors.

In particular, the highly watched Business Activity Index within the Report on Business can be used as an indicator of the overall health the services sector. The business activity index jumped 4.6 percentage points to 59.7, signaling accelerated activity and 51 consecutive months of growth. The index for new orders fell from 59.6 to 56.8, still indicator growth but at a slower rate than before. The index for employment jumped from 52.7 to 56.2, suggesting that service-sector hiring picked up in October.

Meanwhile, overall business activity in China continued to expand in October, according the composite HSBC China Services PMI report, which is compiled by Markit Economics. The index, which measures business activity within both manufacturing and services, increased to 51.8 from 51.2, indicating accelerated, although relatively modest, growth. Manufacturing output increased for the third consecutive month, new orders accelerated to a seven-month high, and composite-level employment increased for the first time since March.

“Service sectors are likely to find support from the ongoing recovery of manufacturing growth and signs of improving labour market conditions,” said Hongbin Qu, HSBC’s China chief economist and co-head of Asian economic research. “This should help cement China’s growth momentum in the coming months.”

Businesses are looking for strong growth in both countries in the fourth quarter to help justify near-record equity valuations. Strong service-sector performance should be a tailwind for overall economic conditions, but between quantitative easing and relatively strong corporate earnings, equities have shot up to valuations that some believe aren’t sustainable in the still low growth environment.